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June 2, 2009

Options Exchanges Ready New Linkage Plan

By Peter Chapman

The country's options exchanges are set to scrap their centralized order-routing system and replace it with a collection of individual, private linkages this summer.

The new routing setup incorporates Regulation NMS-type rules and promises to improve execution quality for large lot orders. It is also expected to reduce costs for market makers and introduce various efficiencies to options trading.

Peter Armstrong

According to Peter Armstrong, an NYSE Euronext executive and head of the Options Linkage Authority, which oversees the existing linkage plan, the exchanges will make the switch at the end of July or August.

"The 'distributed linkage' plan is based on the Reg NMS structure used in equities, involving intermarket sweep orders and private routing," Armstrong told executives gathered for the Options Industry Council's annual conference in Weston, Fla., last month.

The final plan is still awaiting Securities and Exchange Commission approval. Because it involves the national market system, it must be approved by the SEC's commissioners, not just staff. Both the overall plan and rule changes within the individual exchanges must be approved.

The plan has been in the works for at least a year and a half, requiring agreement by all seven options exchanges. It is taking longer than expected, exchange officials say, because of the need for SEC guidance on certain regulatory issues, such as those involving trade-throughs. The SEC has been unable to give its full attention to the issue due to the larger problems in the U.S. banking industry, sources say.

If approved, the scheme would replace the current linkage plan, established in 1999. The current plan involves a set of rules governing order types and an order-routing system operated by the Options Clearing Corp. The plan is overseen by the Options Linkage Authority, which is made up of members from the seven exchanges.

Alan Grigoletto, senior vice president of business development and marketing for the Boston Options Exchange, says his bourse will be ready but believes the deadlines might "slip a little bit." BOX plans to deploy routing technology supplied by Interactive Brokers and Goldman Sachs, Grigoletto told the OIC crowd.

Tom Wittman

Tom Wittman, president of the Nasdaq OMX PHLX exchange, formerly the Philadelphia Stock Exchange, views the switch as a positive and will use routing technology provided by Nasdaq. Wittman billed the switch-over as a win for Philly specialists.

"Right now they are carrying the burden of some of the expenses that are incurred when we link away to make/take exchanges or pay order fees to other exchanges," he said at OIC. Wittman's exchange will now pass those fees onto the end customer. "It will be a very low transaction cost," he said.

In general, the goal of the plan is to speed up trading of large lots. Due to penny trading, there is less liquidity at the inside.

Also, liquidity is spread out over multiple exchanges. All this frustrates buyside traders who want to be able to get size done quickly.

The plan's use of intermarket sweep orders-currently in use in the equities market-is central to the plan. ISOs would make it easier for traders to comply with trade-through rules, permitting them to trade large lots in fewer places.

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